SunTrust Bank v. Matson (In re CHN Construction, LLC)SunTrust Bank v. Matson (In re CHN Construction, LLC)
Contested Matter
MEMORANDUM OPINION
Before the Court in this contested matter
At the conclusion of the Hearing, the Court ruled in favor of the Trustee and denied SunTrust’s Motion. The Court found that SunTrust was unable to establish a right to assert derivative standing to pursue the avoidance actions over the objection lodged by the chapter 7 Trustee.
Jurisdiction and Venue
The Court has subject matter jurisdiction over this contested matter pursuant to 28 U.S.C. §§ 157(a) and 1334 and the General Order of Reference from the United States District Court for the Eastern District of Virginia dated August 15, 1984. This is a core proceeding under 28 U.S.C. § 157(b)(2). Venue is appropriate in this Court pursuant to 28 U.S.C. § 1409.
Factual and Procedural Background
On December 21, 2011 (the “Petition Date”), CHN Construction, LLC (the “Debtor”) filed a voluntary petition under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).
Early in the bankruptcy case, the Court entered a Consent Order -Conditioning the Rights of the Debtor in Possession (the “Order Conditioning Rights”).
Following entry of the Order Conditioning Rights, the Court entered a consent order between the Debtor and SunTrust on March 8, 2012, that authorized the Debtor to use cash collateral (the “Cash Collateral Order”).
Following entry of the Cash Collateral Order, the Debtor did not provide Sun-Trust with the financial reporting information it was entitled to receive. Subsequently, between June 2013 and May 2014 (the “Blackout Period”), the Debtor failed to file its monthly financial reports with the Court as required by the Order Conditioning Rights. The Debtor advised Sun-Trust that its failure to file monthly financial reports during the Blackout Period was due to the fact that the Debtor was not operational and on the brink of liquidation. SunTrust, for whatever reasons, chose not to exercise its right to terminate the Debtor’s ability to use cash collateral despite the Debtor’s failure to comply with the terms of the Cash Collateral Order and despite its failure to file any of the requisite monthly financial reports during the Blackout Period.
On May 28, 2014 (the “Conversion Date”), this case was converted from chapter 11 to chapter 7 on the motion of the Office of the U.S. Trustee. The Trustee was subsequently appointed to serve as the chapter 7 trustee in this case, and he continues to serve in that capacity. Sun-Trust thereupon conducted an investigation into the condition of its remaining collateral. The investigation revealed that during the Blackout Period, the Debtor had been paid $940,771.60 on account of a subcontract, executed in December 2012, between the Debtor and the Thompkins-Ballard Joint Venture in connection with the construction of a city jail facility. The Debtor had engaged in approximately fifty-five separate post-petition transactions with suppliers and subcontractors of the Debtor (the “Post-petition Transfers”) whereunder checks totaling $666,229.92, issued by Thompkins-Ballard Joint Venture and payable to the Debtor and the Joint Payees, had been negotiated by the Joint Payees. The Debtor did not disclose these payments to SunTrust or to the Court. Further investigation revealed that the Debtor retained $284,541.68 of SunTrust’s cash collateral, which was not deposited into the DIP Account as required by the Order Conditioning Rights.
SunTrust requested the Trustee to commence adversary proceedings in order to recover the Post-petition Transfers under Bankruptcy Code §§ 549(a) and 550(a). After a careful review and thoughtful analysis of the information and documentation provided by SunTrust pertaining to the Post-petition Transfers, the Trustee concluded that the Post-petition Transfers were not avoidable because the Cash Collateral Order had authorized payment of them. Accordingly, the Trustee declined to bring the avoidance action. As a result of the Trustee’s decision, SunTrust filed the instant Motion so that it could pursue the Post-petition Transfers in the stead of the Trustee on behalf of the Estate.
Analysis
Section 550 of the Bankruptcy Code allows the trustee to “recover, for the benefit of the estate, the property transferred” under Bankruptcy Code §§ 544, 545, 547, 548, 549, 553(b), or 724(a) “or, if the court so orders, the value of such property.” 11
Except for very limited situations, only the legal representative of the bankruptcy estate can assert the avoiding powers set forth in the Bankruptcy Code.
Section 550(a) and each of the sections of the Bankruptcy Code enumerated therein provide that it is the trustee (or debtor in possession)
Despite this general rule, there are two limited situations where a creditor has been permitted to pursue avoidance actions on behalf of a trustee or debtor in possession. Both of these exceptions have been confined to cases arising under chapter 11 of the Bankruptcy Code and would appear to have little, if any, applicability to chapter 7 cases. While the Fourth Circuit has never decided whether a creditor may bring a derivative suit on behalf of the trustee, it observed in Scott v. National Century Financial Enterprises, Inc. (In re Baltimore Emergency Services II, Corp.) that:
Our sister circuits that acknowledge the doctrine have allowed a bankruptcy court to grant derivative standing to a creditor or creditors’ committee in two limited circumstances. First, several circuits have recognized such standing when the trustee or debtor-in-possession unreasonably refuses to bring suit on its own. See, e.g., [Smart World Techs., LLC v. Juno Online Servs., Inc. (In re Smart World Techs., LLC),423 F.3d 166 , 176 (2d Cir.2005) ]; Official Comm. of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery,330 F.3d 548 , 583 (3d Cir.2003) (en banc); Fogel v. Zell,221 F.3d 955 , 965 (7th Cir.2000); Canadian Pac. Forest Prods. Ltd. v. J.D. Irving, Ltd. (In re Gibson Group, Inc.),66 F.3d 1436 , 1440-41 (6th Cir.1995); La. World Exposition v. Fed. Ins. Co.,858 F.2d 233 , 247-48 (5th Cir.1988). Second, two circuits have permitted creditor derivative actions when the trustee or debtor-in-possession grants consent. See In re Smart World Techs.,423 F.3d at 176 n. 15; Avalanche Mar., Ltd. v. Parekh (In re Parmetex, Inc.),199 F.3d 1029 , 1031 (9th Cir.1999).
Chapter 11 of the Bankruptcy Code provides for the first exception — when the trustee grants consent. Bankruptcy Code § 1123(b)(3)(B) provides that a chapter 11 plan of reorganization may provide for “the retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any [claim or. interest belonging to the debtor or to the estate].” 11 U.S.C. § 1123(b)(3)(B). In 2001, the United States Court of Appeals for the Second Circuit decided a case that involved a suit brought by the unsecured creditors’ committee, on behalf of the debtors in possession, against various directors and officers of the debtor corporation. In re Commodore International, Ltd.,
acquire standing to pursue the debtor’s claims if (1) the committee has the consent of the debtor in possession or trustee, and (2) the court finds that suit by the committee is (a) in the best interest of the bankruptcy estate, and (b) is “necessary and beneficial” to the fair and efficient resolution of the bankruptcy proceedings.
Id. at 100 (citing In re Spaulding Composites Co.,
The second exception — when the trustee unreasonably refuses to bring suit on its own — arises in situations where the trustee or chapter 11 debtor in possession is either unwilling or unable to bring the cause of action. This may occur when the debtor is a closely held corporation and the corporation is unwilling to bring suit against the principal that controls it. In such a situation, bankruptcy courts have considered whether a separate entity may pursue the cause of action on behalf of the bankruptcy estate. For example, in Airocare, Inc. v. Chambers (In re Airocare), No. 10-14519-RGM,
The “unreasonable withholding of consent” test, while appropriate in some chapter 11 cases, breaks down entirely in the chapter 7 context. The Trustee, as an independent fiduciary responsible for the recovery, preservation, liquidation, and distribution of the Debtor’s chapter 7 estate, is charged with administering the estate in a manner that is “compatible with the best interests of parties in interest.” 11 U.S.C. § 704(a)(1). If the Airocare test were applicable to' chapter 7 proceedings, the language in the second part of the two-part test would be superfluous. The trustee is already charged with fulfilling those duties in every chapter 7 case. The chapter 7 trustee needs to be provided a substantial degree of discretion in determining how to most effectively administer the
But even if the Court were to apply the Airocare test, the Court finds that SunTrust has failed to satisfy the requirements of that test. The Trustee’s refusal to bring suit under Bankruptcy Code §§ 549 and 550 was not unreasonable. The Trustee gave careful consideration to SunTrust’s request. After an examination of the potential claim, the Trustee determined that it was not colorable. The Trustee concluded that the Cash Collateral Order specifically authorized the payment of “reasonable, necessary costs and expenses of operating and maintaining its business, including ... to suppliers and subcontractors necessary to maintain the continuation and going value of the Debt- or.” It was this provision of the Cash Collateral Order that allowed the Debtor to make the Post-petition Transfers. In the Trustee’s view a claim under Bankruptcy Code § 549(a)(2)(B) would likely fail.
The Trustee acknowledged at the Hearing that, even without merit, the causes of action potentially had some “hold up value.” In the Trustee’s reasoned opinion, however, claims lacking merit should not be brought merely to extort settlement. As an officer of the Court, the Trustee believed it was his duty not to do so.
The Trustee further considered that SunTrust was in a better position to police the Debtor’s conduct during the pendency of the chapter 11 phase of this case than were the Joint Payees. At no point during the Blackout Period did SunTrust exercise its right to terminate the Debtor’s use of cash collateral, despite the fact that Sun-Trust now alleges that the city jail project did not promote the continuation of the Debtor as a going concern. The Trustee, who is an experienced bankruptcy practitioner and a longstanding member of the panel of trustees,
Thus, exercising his sound business judgment, the Trustee determined that he should not commence these avoidance actions, that it was in the best interest of the
Notes
. Contested matters are governed by Rule 9014 of the Federal Rules of Bankruptcy Procedure.
. 11 U.S.C. §§ 1101-1174. All further references to the Bankruptcy Code are to the Bankruptcy Code as codified at 11 U.S.C. §§ 101 etseq.
. The Bankruptcy Code provides for the appointment of a trustee in a chapter 11 case only for cause or in the best interest of the bankruptcy estate. See 11 U.S.C. § 1104(a). In most chapter 11 cases, the debtor will remain in possession of its property and operate the debtor’s business as the fiduciary of the bankruptcy estate. See 11 U.S.C. § 1101(1). Bankruptcy Code § 1107 provides:
Subject to any limitations on a trustee serving in a case under this chapter, and to such limitations or conditions as the court prescribes, a debtor in possession shall have all the rights ... and shall perform all the functions and duties, except the duties specified in sections 1106(a)(2), (3), and (4) of this title, of a trustee serving in a case under this chapter.
11 U.S.C. § 1107.
.Bankruptcy Code § 363 prohibits a trustee or debtor in possession from using, selling, or leasing cash collateral without the consent of the entity that has an interest in the cash collateral or the approval of the court after notice and a hearing. 11 U.S.C. § 363(c)(2). Cash collateral is broadly defined by the Bankruptcy Code to include cash and cash equivalents in which both the bankruptcy estate and another entity have an interest. See 11 U.S.C. § 363(a). In the case at bar, the Debtor’s property that had been pledged to secure the Notes constituted SunTrust’s cash collateral.
.The avoiding powers permit the trustee to undo transfers that occurred for the most part during the pre-petition period preceding the commencement of a bankruptcy case. Section 544, commonly referred to as the trustee’s "strong-arm” power, provides the trustee with the power to avoid certain pre-bankruptcy transfers made by the debtor that could have been avoided by a judgment lien-holder or a bona fide purchaser. 11 U.S.C. § 544. Section 545 allows the trustee to avoid the fixing of certain statutory liens on the debtor’s property. 11 U.S.C. § 545. Section 547 allows the trustee to avoid certain preferential transfers made by the debtor pri- or to the commencement of the bankruptcy case. 11 U.S.C § 547. Section 548 allows the trustee to avoid fraudulent transfers made by the debtor prior to the commencement of the bankruptcy case. 11 U.S.C. § 548. If a creditor exercises its right of setoff within ninety days of the commencement of the case, § 553(b) allows the trustee to recover the amount offset from that creditor if certain conditions are satisfied. 11 U.S.C. § 553(b). Section 724(a) allows the trustee to "avoid a lien that secures a claim of a kind specified in section 726(a)(4) of ... title [11].” 11 U.S.C. § 724(a).
. Section 522(f)(2) of the Bankruptcy Code, for example, authorizes an individual debtor under some circumstances to avoid certain liens to the extent they may impair an exemption. 11 U.S.C. § 522(f)(2).
. The Bankruptcy Code defines the term “disinterested person”.as one who, among other things, does not have an interest materially adverse to the interests of the estate or any class of creditors. See 11 U.S.C. § 101(14).
. In a case under chapter 11 of the Bankruptcy Code, the debtor in possession has the rights and responsibilities of a trustee. See supra note 3.
. The Office of the U.S. Trustee is responsible for the supervision of chapter 7 trustees. See 28 U.S.C. § 586(a)(1). The Trustee was subject to removal if his conduct was deemed unreasonable or detrimental to the bankruptcy estate. No such motion was brought before the Court in this case.
. There is serious question whether the Post-petition Transfers were even property of the estate. See, Mid-Atlantic Supply, Inc. of Va. v. Three Rivers Aluminum Co.,
.The Office of the United States Trustee has established and maintains a panel of private trustees in each region that are eligible to serve as trustees in cases filed under chapter 7 of the Bankruptcy Code. See 28 U.S.C. § 586(a)(1).
. The Court notes that, as the Trustee is paid on a commission basis, he had a financial incentive to recover the Post-petition Transfers, if it were appropriate to do so.